Question

Tailor Corp. is considering purchasing one of two new diagnostic machines. The following estimated data has been determined by management: Machine 1 Machine 2 Initial cost $40,400 $50,950 Estimated life 5 years 5 years Salvage value $1,180 $1,450 Estimated annual cash inflows $15,150 $19,800 Estimated annual cash outflows $4,000 $7,050 Click here to view PV table. Calculate the profitability index assuming a 5% discount rate. (For calculation purposes, use 5 decimal places as displayed in the factor table provided, e.g. 1.25124 and final answers to 3 decimal places, e.g. 1.251.) Profitability Index Machine 1 Machine 2 Based on your answer, which project should the company choose?

Answer 1

Calculation Of Present value of net annual cash inflow and salvage value
Year	Particulars	Discount Factor@5%	Machine A		Machine B
			Cash Flow	Discounted Cash Flow	Cash Flow	Discounted Cash Flow
1	Net Annual Cash Inflow	0.95238	11150	10619.05	12750	12142.86
2	Net Annual Cash Inflow	0.90703	11150	10113.38	12750	11564.63
3	Net Annual Cash Inflow	0.86384	11150	9631.79	12750	11013.93
4	Net Annual Cash Inflow	0.82270	11150	9173.13	12750	10489.46
5	Net Annual Cash Inflow	0.78353	11150	8736.32	12750	9989.96
5	Salvage Value	0.78353	1180	924.56	1450	1136.11
	Present Value			49198.23		56336.94
	Profitability Index
				Machine A		Machine B
	a	Initial Investment		40400		50950
	b	Present Value of net cash flows		49198.23		56336.94
	c	Profitability Index (b/a)		1.218		1.106
	Project A should be selected.